Canada’s strong economic performance of the past decade continued in 2007 but growth will moderate this year, according to a report released today by the International Monetary Fund (IMF).

The IMF announced it has completed its annual review of Canada’s economic developments and policies.

According to the report, financial conditions have been modestly affected by the spillovers from the global liquidity crunch in the money markets. Interbank spreads for major Canadian banks rose, although not as much as in other major markets, it added. The report’s researcher’s noted that the extent of financial vulnerabilities has so far been limited owing to relatively low exposures to asset-backed securities, but uncertainties remain with respect to the impact of further deterioration in U.S. financial market conditions.

Real GDP growth was about 2.5% in 2007, which the researchers attribute to robust growth in domestic demand—particularly private consumption and residential investment.

But growth slowed toward the end of the year, and is expected to decelerate further, to 1.8% in 2008, reflecting a sharp downturn south of the border, past currency appreciation, and a tightening of financial market conditions.

Core inflation, which had been on the rise earlier in the year, declined in the second half of last year, owing to stronger-than-expected exchange rate pass-through.

Despite strong gains in the terms of trade, the account surplus narrowed to 1% of GDP in 2007 as real net exports declined sharply. The latter largely reflected a sharp deterioration in the manufacturing trade balance in response to the currency appreciation and the slowing U.S. economy, but also increasing imports, the report notes. It adds that the Canadian dollar has appreciated by 45% in real terms since 2002, although domestic adjustment to the appreciation has been smooth thanks to flexible labor markets.

The IMF applauded the Bank of Canada’s moves to reduce policy rates to 4% in December and January and noted that there may be room for further reductions in the overnight rate in the near term. As well, the directors welcomed the Bank’s commitment to increasing the transparency of its decision-making process.

The IMF researchers noted that a prudent fiscal policy framework for the last decade has provided for 10 consecutive years of budget surpluses, and public debt ratios have declined. The budget surplus for fiscal year 2006/07 was estimated at 1% of GDP, half a percentage point above the budget forecast, reflecting buoyancy of corporate income tax revenue. The IMF agreed with the focus on tax cuts—a 1% cut to the GST and corporate tax reductions to 15%— in the government’s 2007 Economic Statement, in particular the cuts to corporate taxes, as it noted Canada’s are relatively high.

After IMF staff prepares the annual report on Canada, it is presented to the executive board for discussion and assessment. This year, the executive directors praised Canada’s macroeconomic track record since the mid-1990s, in particular, strong GDP growth and declining unemployment, low and stable inflation and consecutive fiscal surpluses with attendant reductions in the federal debt-to-GDP ratio achieved during this period.

Looking ahead, the directors said the potential slowing of the U.S. economy would affect the near-term outlook for Canada. Therefore, they welcomed the recent measured easing of policies and considered that the economy, grounded in strong fundamentals, is well poised to meet the near-term challenges. While recognizing the uncertainty of demand, the director’s also supported Canada’s continued attention to medium-term considerations of productivity growth and policy reforms.

“The IMF report shows Canada is an economic leader, and our government is taking steps to ensure continued growth in the face of uncertainty,” said Finance Minister Jim Flaherty, in response to the report.

In terms of fiscal policy, the IMF directors agreed that the over-performance projected for the current year had provided room for the October tax relief but pointed out that some of the revenue gains underlying the budget surplus could be temporary and therefore suggested that spending restraint will be key in the medium-term.

The IMF said Canadian banks are quite resilient to financial market strains compared with many other countries and stressed the importance of continuing vigilance in this area. As well, a number of the directors noted that a further opening of the Canadian banking system to takeovers would boost market flexibility, support financial innovation, and widen access to finance.

@page_break@The IMF executive board said that there would be benefits in embracing a single securities regulator, as exists in many other industrialized countries, to improve further the efficiency and effectiveness of securities’ market regulation.

Last week, Flaherty announced the creation of an expert panel charged with looking into securities regulation in Canada and providing advice and recommendations on issues such as the value of a single securities regulator. The panel is chaired by Tom Hockin, former Minister of State (Finance) and former president of the Investment Funds Institute of Canada.

“I am asking the panel to develop a model common securities act to create a Canadian advantage in global capital markets,” said Flaherty, about the new panel.

A previous committee headed by Purdy Crawford drafted a plan for a single Canadian securities regulator back in 2006, but nothing came of it.

“The actions we and all Canadians take today will determine where we end up tomorrow,” said Flaherty, in a release today. “The question all of us face in 2008 is how to secure our future prosperity in these challenging economic times.”